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Tax Strategies & Credits

Child Care Tax Credits Might Help You Absorb the Costs

by
Spencer Wilson
on
12/18/2017
Child Care Tax Credits Might Help You Absorb the Costs

If you’re a parent of a child under the age of 13 or a dependent who needs care, then working can be a double-edged sword. You need employment to pay your bills, but you also need to pay for supervision for the hours that you’re away from your home. You even need those care arrangements when you’re first looking for a job!

In recognition of the additional expenses faced by taxpayers with young children or dependents in certain categories, the federal government has established child care tax credits ranging from 20 percent to 35 percent of the costs of childcare. The credit is for expenses up to $3,000 for a single child or $6,000 for two or more children, and the percentage of the credit available for that expense is based on your adjusted gross income, as seen in the table below:

The calculation of the credit is fairly straightforward. After you determine what your adjusted gross income is for the year, you find the category that it falls into to find the applicable percentage. You then multiply your eligible expense by that number to find out what your credit is.

So if you have two children under the age of 13 for whom you pay a total of $4,000 in eligible child care expenses, and your adjusted gross income is $34,000, you would multiply the $4,000 expense by 25 percent for a total of $1,000. You would get a $1,000 nonrefundable tax credit off of the taxes that you owe for the year. Nonrefundable means that you don’t get money back: as long as the taxes you owe are $1,000 or above, the full credit would be applied. If, however, you only owe $800 in taxes, your credit would zero out the amount you owe but you would not get the remaining $200 credit in cash – the excess would simply not be applied. 

What You Need to Know About the Child Tax Credit

Though the ability to take the child tax credit is fairly straightforward, it does have some nuances that you need to be aware of. These include: 

  • How Much You’re Allowed to Count As Child Care Expenses. The credit is limited to the amount of money that you make as earned income. Earned income is generally considered your net self-employment income combine with your wages. If you are married and file jointly, the maximum amount that you can show as a childcare expense is the earned income of the spouse who has the lower of your two incomes.
  • Age Restrictions – The child care credit is only available for dependent children who are under the age of 13. If you are paying for childcare for a dependent child who turns 13 during the tax year, you are able to use the credit for each of the months before their birthday. There are special rules that apply for dependents who are 13 or over but are disabled and unable to care for themselves, whether as a result of a physical or mental disability. In some cases, this type of individual does not have to be your dependent in order for you to take the credit.
  • Credit is Only Available for Dependents. Except for instances of disability as indicated above, in order to claim the tax credit for a child’s care expenses, you must also claim the child as your dependent. This requirement is particularly important in cases of divorce where one spouse pays all or part of the care expenses and the other claims the dependency exemption. Where parents are able to come to an agreement regarding the dependency write-off, there is a special rule that can be applied that overrides this requirement.
  • Care Expenses Beyond Daycare – In addition to expenses for daycare services, there are other childcare expenses which are eligible for the child care credit. These include day caps or other programs that provide supervision when parents are not available, but overnight camp or educational expenses such as the cost of school (other than below kindergarten level) or tutoring do not apply. Overnight camps or school/educational expenses may be eligible for the deduction for medical expenses if their purpose is specialized resources or relief for a mental or physical disability.
  • Eligible Daycare Expenses – In order to qualify for the child care tax credit, daycare expenses must be paid to facilities that provide oversight of over six individuals and be in compliance with local and state laws. If care is provided inside your home, you need to determine whether payment to the caregiver is as an independent contractor or an employer. If you an employer, you may be required to pay Social Security and Medicare taxes, unemployment taxes, and prepare a W-2 for the caregiver each year. If your child’s care is provided in the caregiver’s home this is not necessary. Also, keep in mind that in order to get the child care tax credit, your caregiver cannot be one of your dependents or your spouse, and cannot be your child under the age of 19, regardless of whether they are your dependent or not. Check with a tax professional to see whether these requirements or restrictions apply to your situation.
  • Employer-Provided Dependent Care Benefits – If your employer provides you with tax-free dependent care benefits that are excluded from your income, you can use them for up to $5,000 of qualifying child care expenses, but if you use these funds then you need to subtract the amount you use from the qualified expenses before you calculate your credit. If your employer provides over $3,000 in these types of benefits and you only have one child, any dollar amount over $3,000 is subject to tax.
  • Earned Income Allowance – For each month that a taxpayer is either disabled or a full-time student, or whose spouse is disabled or a full-time student, there is an earned income allowance of $250. 
  • Restrictions on People Filing Married but Separate – The child care tax credit is generally not available for those who use the filing status married but filing separately. However, under certain circumstances, an individual who is married can take advantage of a special status. For more information, contact a tax consultant or financial manager.
  • Documentation Requirements  - As is true with most tax issues, it is important that you record and retain all appropriate information in order to support your claim of the childcare tax credit. The information that is required by the IRS includes the caregiver or facility’s name and address, as well as their tax I.D. number. This is true for each child for whom you claim the credit up to the maximum expense allowed. Your state may have similar requirements if they also offer a credit for child care expenses.

The child care tax credit can offer a significant tax benefit, so it’s important that you understand all of its details in order to fully take advantage of it. To learn more about how it applies to you, contact a tax professional to set up an appointment.

Spencer Wilson writes for TaxBuzz, a tax news and advice website. Reach him at [email protected].

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Spencer Wilson

Spencer Wilson

Spencer Wilson, EA is a tax preparer based in Long Beach, CA. Spencer Wilson Financial Management Services has been serving the Greater Los Angeles Area and Orange County since 2004. <br /> We began in the heart of Naples in Long Beach and we continue to work hard offering tax preparation and planning, business accounting and bookkeeping and payroll services . <br /> We have helped many different people and businesses succeed financially and take control over their finances.

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